The Most Important Chart In America

We want to be buying stocks. I don’t think I can be any more clear about that.

You guys know me as the obnoxiously bullish guy the past couple of years in the midst of “unprecedented pessimism”. I’m willing to admit that I have an unfair advantage that I just pay attention to price and purposely ignore everything else that most of you have to endure. This focus has allowed me to see clearly what is actually taking place instead of assuming that who I’m listening to or reading knows what’s going on.

Today I want to show you guys one single chart that I think tells the story of what the hell is going on here. It is awfully difficult for me to be bearish of stocks if the most important sectors in America are not just making new highs, but also breaking out to new relative highs. These leading sectors aren’t just doing well, they’re outperforming the rest.

The way I see it, we don’t have bull markets in America without the participation of Banks. Take a look at a chart of J.P. Morgan going back 100 years and overlay the S&P500. I couldn’t tell you which one is which. They look the same. This correlation makes Financials extremely important. As consumers, where and how we spend our discretionary income helps managers determine how much to allocate into that area: autos, homebuilders, retail. These aren’t areas managers like to invest in heavily while markets are falling. To the contrary, Consumer Discretionary is a sector overweight if managers think stocks are going higher.

Technology is the biggest sector in America representing almost a quarter of the entire index. No explanation needed here – this is a monster. And finally, Industrials actually have the highest r-squared with the S&P500 going back historically. So if we want to know where S&Ps are going, Industrials are mathematically the most important sector, although many of us might argue Tech and/or Financials are priority 1. But either way, I think we can all agree, bulls and bears, that these are the sectors that need to do well for stocks as an asset class to continue higher.

Notice how Financials, Consumer Discretionary and Tech have all broken out to new highs relative to the S&P500. Industrials are the only ones we’re waiting for. So the question here is simple: Are the new highs in Banks, Tech and Discretionary all failed breakouts, and the divergence in Industrials is the tell here? Or are they just lagging a bit and the weight-of-the-evidence is pointing to higher highs, considering the relative breakouts in all the other sectors?

I’m going to go with the latter. I think the evidence is skewed heavily in favor of stock market bulls. For you hard core bears out there, first of all I’m sorry; life must be hard. But moving forward, I think this is a good one for you guys. If you’re really bearish stocks, for some reason, then you want these relative breakouts to fail: XLF/SPY, XLY/SPY and XLK/SPY. You do not want to see XLI/SPY break out to new highs. That would be another dagger to your already fragile heart portfolio.

Now, as bulls, we don’t want to see Consumer Staples breaking out to new relative highs and outperforming here either. That’s the kind of thing that happens when stocks are falling in prices. In fact, last May I called the Staples/SPX chart, “The most bullish chart in the world”, as it was in the process of completing a major top. This ratio has crashed since then, which is normal while stocks as an asset class are rising rapidly. It would take a failure of these 3 breakouts mentioned above for me to become more skeptical of the strength in this market. Until then we want to err on the long side of stocks.

I pride myself in waking up every morning not worrying so much about the direction of the market or the implications that may come along with that. I only like to find risk vs reward opportunities skewed in our favor and in the direction of the primary trend. This helps increase probability, but more importantly minimize risk. That’s the only thing we’re here to do.

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